Wednesday, August 22, 2012

INNOVATION IS THE ONLY SOURCE OF COMPETITIVE ADVANTAGE

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Innovation is the Only Sustainable Source of Competitive Advantage

“An innovative business is one which lives and breathes ‘outside the box’. It is a combination of good ideas, motivated staff, and an instinctive understanding of what your customer wants.” (Branson, R., 18)

Every business must grow in order to survive. Innovation involves using ideas and knowledge to create products and services, which create consumer demand in the marketplace. “The innovation process is a cycle in which ideas, talent, design skills, money and management expertise come together to create commercially viable products and services” (London Development Agency, 00, http//www.london-innovation.org.uk/innov_drivers.htm). Therefore, innovation is the fuel for the engine of growth within an organisation (Innovation In Action, 00, http// www.jeffmaynard.com/innovate.htm). Businesses must invest in developing new products, exploiting the potential of new partnerships and seeking out new markets if survival and growth are their aim in today’s hyper-competitive marketplace, ie. they must innovate.

Innovation is then basically, “finding new ways to better perform” (McPhearson, M., 001, pg. ). It can be customer-driven, take for example BMW’s NPD System. To maintain market leadership and the prominence of their brand BMW have developed a very deliberate innovation strategy. They have divided the innovative process into steps; innovation research, innovation management, and, innovation transfer, incorporating a “systematic, but flexible approach” (Seidel et al, 00, pg.) to the generation of new products and ideas, and ensuring their continued success and dominance in the motor-vehicle industry. (Seidel et al, 00). Innovation can also spring from a spontaneous event or a flash of genius, which can be turned into a marketable and saleable product or service. Take for example ‘Lonely Planet’. This company which is now the market-leader in the worldwide travel information industry developed from a small idea by Tony and Maureen Wheeler to write a book about their travels across Asia (Johnson, G., Scholes, K., 00). Innovation can occur both by accident and deliberately in almost all industries, but in organisations where survival depends on a constant stream of new products and services, then, it is imperative that innovation is a deliberate and well-resourced business process.

According to David Teece’s Complementary Assets Framework innovations are a major source of profitability for an organisation, and there are two factors which determine whether an innovation is beneficial for a firm � imitability and complementary assets. Figure 1 below illustrates when an innovation can lead to increased profitability for a firm.

If imitability is high and complementary assets are “freely available or unimportant” (Afuah, A., Tucci, C.L., 001, pg. 71) then generating revenues is difficult. However, if complementary assets are “tightly held and important” (Afuah, A., Tucci, C.L., 001, pg. 71) then whoever owns these complementary assets stands to make some money. When imitability is low, the innovator will profit, even if complementary assets are “freely available or unimportant” (Afuah, A., Tucci, C.L., 001, pg. 71). Nonetheless the firm hoping to become profitable would be best positioned where imitability is low and complementary assets are “tightly held and important” (Afuah, A., Tucci, C.L., 001, pg. 71) because in this position the barriers to entry are high and the threat of substitutes and new entrants is low. Hence, it is clear that innovation can and does generate profits for an organisation (Afuah, A., Tucci, C.L., 001). But, while it does lead to increased profitability, and therefore a competitive advantage for firms, is innovation the only source of competitive advantage for those firms, and more importantly, is it the only source of sustained competitive advantage?

“Competitive Advantage is at the heart of a firms performance in competitive markets” (Porter, M., 185, pg. 15).

Finding a common definition for the term ‘competitive advantage’ however, is not easy. Traditionally it was seen as a firm consistently earning a higher rate of return than its competitors (Beal, R., 001). Michael Porter argues that competitive advantage is about successfully translating your competitive strategy into a competitive advantage (Porter, M., 185). In his article, ‘Competitive Advantage Sustainable or Temporary in Today’s Dynamic Environment?’ Reginald Beal states that competitive advantage is “the achievement of above average industry profitability” (Beal, R., 001, pg.5). Therefore, it can be said that competitive advantage incorporates one’s ability to outperform one’s rivals on the primary performance goal, profitability. However, it is ‘sustaining’ this competitive advantage that creates an industry leader. It should be noted at this stage that many researchers have questioned this notion of “sustained” competitive advantage, asking, is there such a thing, and if yes, what exactly constitutes “sustained”. They argue that terms such as ‘long-term’ and ‘in the future’ are ambiguous and lack specificity. Beal proposes that in order to determine a state of sustained competitive advantage a firm’s performance must be examined in each of the four industry life-cycle stages � introduction, growth, maturity and decline. A company is said to possess sustained competitive advantage if it yields “above average financial performance in two or more stages of the industry lifecycle” (Beal, R., 001, pg. ). However for the purpose of this discussion sustainable competitive advantage is looked at from a more simplistic perspective and is defined as “above average performance in the long run” (Porter, M., 185, pg. 11). In other words, sustainable competitive advantage is about outperforming your rivals over a long period of time. This ‘out-performance’ can be achieved by differentiating (ie. offering something unique and inimitable to you customer) or, by striving to become and becoming, the lowest cost producer in your industry (Beal, R., 001).

Traditionally, gaining sustainable competitive advantage was primarily dependent on barriers to entry � patent protection, economies of scale, access to capital, and regulated competition (cost advantages) and, differentiation advantages such as a unique (inimitable) activity or product that was seen as valuable by the customer. The competitive advantage was seen as more sustainable the greater the number of sources of cost or differentiation advantages (Beal, R., 001). However, in today’s global marketplace, where the scale and pace of change are so rapid, this traditional view is being challenged, and innovation, speed, adaptability and efficiency are becoming key drivers for the competitively positioned firm (McPhearson, M., 001). With the birth of the Resource-Based View of the firm, a firms resources (assets, capabilities, processes, competencies) have become the key consideration when discussing sustained competitive advantage. Resources that are non-imitable, non-substitutable and nontransferable are sources of sustained competitive advantage. Therefore, in contrast with the traditional view, the RBV shifts the focus of competitive advantage from the external to the internal (Beal, R., 001). In Michael Porter’s ‘What is Strategy?’ article he articulates that in order to remain competitive, companies must be, flexible to respond rapidly to competition and changes in the marketplace, “outsource aggressively to gain efficiencies” (Porter, M., 16, pg. 1), engage in continuous benchmarking in a bid to have best practice, and above all, develop and maintain a number of core competencies to keep ahead of the competition. (Porter, M., 16). Porter identifies five competitive forces which must be considered by firms aiming to gain sustainable competitive advantage. These include, the bargaining power of suppliers, the bargaining power of customers, the threat of substitutes, rivalry among firms in the industry, and the threat of new entrants into the industry. Gaining a sustained competitive advantage is determined by fast and effective responses to these five forces. (Afuah, A., Tucci, C.L., 001). Kathleen M. Eisenhardt argues that to sustain a competitive advantage firms must “focus on unique strategic processes with simple rules, on the modular patching of businesses to fleeting market opportunities, and on evolutionary timing for ongoing strategic moves” (Eisenhardt, K.M., 00, pg. 4). Joe Peppard, in his article ‘Strategic IS/IT Planning’ states that sustained competitive advantage can be achieved through alignment of the business and the IS/IT strategy, and using these two to introduce new products and services and retain new customers (Peppard, J., 1). Peter Drucker also focuses on the customer as the means for sustainable competitive advantage. He articulates that success comes through determining what the customer really wants and focusing all the company’s resources on satisfying these wants. (Drucker, P., 18).

From the research cited and arguments presented in the paragraph above, it is obvious that while innovation does play a major role in sustaining the competitive advantage of a company, it is not in itself the only factor affecting this sustainability. Firstly, some of the traditional factors mentioned such as patent protection and economies of scale still contribute greatly to the competitive advantage of firms. Take priceline.com, with their patented ‘Name Your Own Price’ Strategy. PriceLines most valuable resource is this patent which almost assures PriceLine will continue to lead the unique reverse auction market. PriceLine is essentially without peers at the moment, and there are few other firms that have such a vibrantly growing market all to themselves. Not many companies have a model that can match the scope of eBay, but PriceLine is one of them. Yet unlike the eBays and Amazons of the world, PriceLine doesn’t have to worry about well-funded competitors coming in and nibbling away at market share. Therefore PriceLine could be said to have a ‘sustained competitive advantage’ for the foreseeable future. Also, the academics referenced identify a number of other factors which are major contributors to the competitive advantage of firms. These include, inter alia, speed, adaptability, efficiency, flexibility, strategic processes, anticipation and relationships.

In my opinion, the essence of sustainable competitive advantage lies, not in processes or practices, but with the Customer. With increased globalization and the fast-pace hyper-competitive marketplace in which firms are competing, customer value and loyalty are paramount, without them firms simply will not survive. Thus, what establishes a firms sustained competitive advantage is “their ability to serve customers’ present and future needs (holistic needs)” (Kandampully, J., Duddy, R., 1, pg.1). The market leading firm must be aware of, and fulfill, both the customers’ present and future needs and it can be argued that sustained success “is essentially determined by its ability to expand and maintain a large and loyal customer base” (Kandampully, J., Duddy, R., 1, pg.1). The firm must create loyalty by creating a type of ‘relationship’ with their customer. They can do this by fulfilling their present needs and anticipating future ones. Like any ‘long-term relationship’ trust is of extreme importance. That is, the firm must win the heart of their customer and create and maintain a trust relationship with them (Kandampully, J., Duddy, R., 1). Creating this ‘relationship’ with your customer can prove extremely valuable. It is five times more expensive to attract a new customer, than to retain an old one, and some of the major benefits of such a relationship include ; “increased purchase, reduced costs, free advertising through word of mouth, employee retention and the life-time value of the customer” (Kandampully, J., Duddy, R., 1, pg.). Through exceptional service and innovativeness (anticipating the customer need) firms will attract and maintain customers, therefore maintaining their position as market leader. It should also be noted that the concept of the ‘relationship’ also takes in other stakeholders, including, employees, suppliers, distributors and shareholders. These relationships serve to create ‘networks’ or partnerships which add to the overall value of the firm and can lead to success for all parties involved. Also, a major challenge for firms today lies in building an environment that successfully creates and nurtures this ‘relationship’ with their customer. The strength of the ‘network’ or ‘partnership’ that exists with the firm’s stakeholders is what underpins and maintains this customer relationship. Loyalty and trust within the firm in turn leads to customer trust and loyalty and therefore creates this ‘long term relationship’ (Kandampully, J., Duddy, R., 1).

Anticipation is another key component of sustained competitive advantage. According to Kandampully and Duddy “there are limited advantages to being a trend setter; it is the trend creator that wins the game” (Kandampully, J., Duddy, R., 1, pg.). Here, of course, innovation is the key. With increased competition and threats from rivals and substitute products sustained competitive advantage can only be reached through constant innovation and growth (staying ahead of the competition). The key however, is to anticipate where the future is headed and where innovation is needed. The successful firm must think for the customer and anticipate their future needs. What works now, may not work in the future, and in order to be successful you must know what is going to work in the future (Kandampully, J., Duddy, R., 1). The firm that fails to “anticipate, react and respond” (Kandampully, J., Duddy, R., 1, pg.) to opportunities in their industry, whether they are deliberate or accidental, will quickly find themselves in the position of market-follower rather than market-leader.

When patenting is not possible it can also be argued that sustainable competitive advantage is achieved when the firm creates a product or service that cannot be imitated. This is especially fitting for service sector firms. Air Canada’s “Star Alliance” for example, where they formed partnerships with a number of airlines, including some of their major competitors created the idea of a single customer interface, providing flexibility for their customers and adding value for all those incorporated in the partnership (Kandampully, J., Duddy, R., 1). Another example would be the online auction site OnSale.com. This company tries to create an inimitable virtual value chain.

It renders value to its customers by enhancing every component along its customer’s value chain. That is; OnSale provides the most complete product description on-line, the auction is the most efficient form of pricing for B-goods, customers are notified by email about their successful bid which is very convenient for them, products are shipped to the customers desired location. OnSale has also developed its own proprietary software over four years, with a team of software engineers. This software can deliver a high throughput of 5000 transactions a day ensuring that OnSale has unique capabilities to deliver the value it boasts to its customers.

Therefore, it is not only innovation which generates sustained competitive advantage for organisations. It is a combination of factors internal and external to the firm. Internal factors are the firm’s own resources and include assets, capabilities, processes, competencies, strategies etc. External Factors include speed to market, adaptability to market changes, efficiency to incorporate and more importantly create best practices, flexibility to change, anticipation of future needs, and, relationships, both internal and external.

To conclude, becoming the leader in your market, ie. creating a sustainable competitive advantage lies in your ability to anticipate future trends (anticipation), take appropriate actions (innovation) and ‘think outside the box’ (relationships) (Kandampully, J., Duddy, R., 1). Sustained competitive advantage can be achieved through embracing and interpreting future customer needs and concerns. Consequently, innovation, while it is important and a key to sustained competitive advantage, is only effective if it is derived from a customer perspective. The key is to become your own customer and therefore develop products and services that “tomorrows customers want, before they become a reality” (Kandampully, J., Duddy, R., 1, pg. 4).

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